Soft Loan Meaning Examples What Is Soft Loan

Soft Loan Meaning

A soft loan means a loan with generally no interest rate or an interest rate lower than the market interest rates. It is offered majorly by government organizations to the developing countries to fund their needs. Soft loans, also called soft financing or concessional funding, have very lenient terms and many grace periods to pay back the loans. Though they are generally offered for the development of the developing countries, sometimes it is also granted to have political and economic ties with a country.

Examples of Soft Loan

Some of the examples of soft loans are as below:

The World Bank is one of the biggest financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more which offers soft loans to various developing countries. The International Development Association is an international financial institution offering concessional financing and grants to the poorer countries of the world. It is a part of the World Bank headquartered in Washington D.C, USA. It was established in 1960 to complement the already existing International Bank for Reconstruction and Development to lend to countries with poor creditworthiness and lower per capita incomeCapita IncomeThe per capita income formula depicts the average income of a region computed by dividing the total income of that area by the total population of the region. It is used to figure out the average income of a city, provision, state, country, etc.read more. International Development and Association (IDA) and International Bank for Reconstruction and Development (IBRD) are collectively known as the World Bank.A country’s government even offers them to promote the nation’s growth. For example, in India, the Small Industries Development Bank of India (SIDBI) offers loans and grants to promote the Make In India campaigns. It helps the MSMEs get money to fund their expansion, which helps the country grow leaps and bounds.Similarly, countries are offering soft loans to other countries to establish strong relations. One example of a country lending to the other is Japan lending money to India for its bullet train project. But here though the interest charged was minimal, Japan had an agreement that India would purchase a certain percentage of machinery required for its bullet trains from Japan. So in this way, Japan helped India get money at a cheaper rate, allowed its industries to grow by exporting the machinery to India, and established good business relationships with India.

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Advantages of Soft Loan

Some of the advantages are as follows:

The poorer countries get easy funding to fund their expansion, and also the time frame offered can be extended.It helps businesses grow, which may not get money from other sources.It helps the countries to establish relationships with each other. For example, China is helping African countries to grow through their soft loans.Generally allows economic collaboration wherein all the countries involved in the soft loan financing benefits in some or the other.The country’s government can promote the businesses and their local players to use this money to expand themselves and help the country grow economically. For example, the Federal Ministry of Finance (FMF) helps businesses in Austria get loans and expand themselves for the overall development of Austria.

Disadvantages of Soft Loan

Some of the disadvantages are as follows:

Sometimes the country getting soft loans may not afford it and can get into a debt trap. An example of such a case is a country named Ethiopia. Ethiopia had got a soft loan from China to fund its expansion. But due to these, the debt to GDP ratioDebt To GDP RatioThe debt to GDP ratio is a metric to compare a country’s debt to its GDP and measures its capability to repay its debt. A country with a high ratio would not have difficulty repaying its debt but will not seek debt due to higher chances of defaulting.read more had risen to 88%, which caused a lot of trouble. Sometimes, the country may not need that much money and may get into trouble if things don’t work out well.The loan terms are lenient, which causes a negative view of the development. The businesses may not take it seriously, and if the business fails, the loan is converted into a grant by the government.

Conclusion

Soft Loans should be taken whenever there is poor creditworthinessCreditworthinessCreditworthiness is a measure of judging the loan repayment history of borrowers to ascertain their worth as a debtor who should be extended a future credit or not. For instance, a defaulter’s creditworthiness is not very promising, so the lenders may avoid such a debtor out of the fear of losing their money. Creditworthiness applies to people, sovereign states, securities, and other entities whereby the creditors will analyze your creditworthiness before getting a new loan.read more and a serious need for a country to grow. The terms of the soft loans are lenient and ability-based. Meaning the borrower is expected to pay back the loan when it can.

With its arms of IDA and IBRD, the World Bank should try its best to offer soft loans for the poorer nations with very low per capita income and in a dire state where it needs money to grow. They can also help a nation grow on the economic front by granting a soft loan to another country with guidelines to get business in return and promote exports. It also helps to establish political and economic relationships with other nations.

The businesses in a country in the nascent stage should make the maximum use of soft loans by governments to grow themselves and help in the development of the nation. The government agencies establish proper guidelines as to who is eligible to get the soft loans, and the granting process involves a lot of parameters.